Ing of debt following two different interest rates

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. ing of 'Debt following two different interest rates are crucial for pricing debt. Coupon (contract or stated) rate The coupon rate of interest is stated in the bond contract; " is used to compute the dollar amount of interest payments that are paid to bondholders dur- ing the life of the bond issue. _Iarket (yield or effective) rate This is the interest rate that investors expect to earn on the investment in this debt security; this rate is used to price the bond. coupon(contract) rateisusedtocompute interestpayments andthemarket (yield)rateis IO price thebond. The coupon rate and the market rate are nearly always different. This use the coupon rate is fixed prior to issuance of the bond and normally remains fixed ghout its life. Market rates of interest, on the other hand, fluctuate continually with the Iy and demand for bonds in the marketplace, general macroeconomic conditions, and the wer's financial condition. The bond price, both its initial sales price and the price it trades at in the secondary market uent to issuance, equals the present value of the expected cash flows to the bondholder. " cally, bondholders normally expect to receive two different types of cash flows: Periodic interest payments (usually semiannual) during the bond's life; these payments are called an annuity because they are equal in amount and made at regular intervals. ingle payment of the face (principal) amount of the bond at maturity; this is called a lump- slim because it occurs only once. bond price equals the present value of the periodic interest payments plus the present value single payment. If the present value of the two cash flows is equal to the bond's face value, bond is sold at par. If the present value is less than or greater than the bond's face value, the ells at a discount or premium, respectively. We next illustrate the issuance of bonds at three nt prices: at par, at a discount, and at a premium.
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Bondslssued~Par To illustrate a bond issued (also said to be sold) at par, assume that a bond with a face amoum: of $10 million, has a 6% annual coupon rate payable semiannually (3% semiannual rate), an a maturity of 10 years. Semiannual interest payments are typical for bonds. This means that th: issuer pays bondholders two interest payments per year. Each semiannual interest payment is equal to the bond's face value times the annual rate divided by two. Investors purchasing these bonds receive the following cash flows. 7-13 Module 7 I Liability Recognition and Nonowner Financing Present value --- factors are from I ••... Payment Present Value Factor" Present Value Appendix A Interest ................. $ 300,000 14.87747 b $ 4,463,200d Calculator Principal ............ ,• .... $10,000,000 0.55368 c 5,536,800 N = 20 $10,000,000 IlYr = 3 PMT = 300,000 FV = 10,000,000 I PV = 10,000,000 i Calculator N = 20 IlYr = 4 PMT = 300,000 FV = 10,000,000 [PV = 8,640,967.37:-: *rounding difference Dollars per Payment Total Cash Flows Semiannual interest payments .
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